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Best Practices in Credit Portfolio Management

This page offers a concise summary of what might be considered Best Practices in Credit Portfolio Management' (CPM). The content builds loosely on the original publications of IACPM[1], the BIS[2] and other sources. For the definition and objectives of CPM see Credit Portfolio Management. CPM may practised by a wide range of entities. This summary aims to be (to the degree possible) agnostic about whether the firm managing the portfolio is a bank, a credit insurer, an asset manager or any other institution exposed to a portfolio of credit risks

Caveats

The best practices outlined here apply to business models that involve ongoing exposure to credit risk (sometimes denoted as buy-and-hold or hold-to-maturity business) as opposed to business models built around exchange based (or OTC) trading of credit risk, e.g. via credit risk sensitive instruments such as bonds or credit derivatives (Trading business models are generally assumed better managed under Market Risk Management, although with significant more difficulty and model risks than trading in more liquid markets)

There is an assumption that the credit portfolio is of a certain size so that a portfolio management approach is meaningful

As a corollary of the previous point, there are meaningful resources dedicated to portfolio management, either as dedicated or shared responsibilities

These best practices are focusing on optimal intrinsic management of credit portfolios and may or may not automatically satisfy (any) regulatory requirements

Last but not least, after the great financial crisis various new concepts and practices are being increasingly used and a new best practices list is by nature an ongoing project

Best Practices Grouping

The best practices list can be grouped for convenience in five conceptual groups

The Organization and Mandate of the CPM function

The Factual Basis (Data) underpinning the framework

The Credit Portfolio Modelling Framework

The use in Business Operations

Linkages with other internal / external frameworks and requirements

Organization and Mandate

1: Clear Portfolio Management Mandate

Formal and Clear mandate by the firm's management / other stakeholders as to what are the objectives and policy instruments available for credit portfolio management activity

8: Portfolio Metadata Management

Linking of data fields to established public standards such as the EBA NPL Template

Credit Portfolio Modelling Framework

1: Objective Risk Based Analytical Framework

The CPM framework aims to represent as faithfully as possible the current state of the portfolio

Comprehensive framework that covers all relevant risks

Culminates into an overall risk capital (or other similar comprehensive metric)

Targets the most objective possible (economic) view of risks (as distinct from regulatory or accounting views) (NB: The introduction of IFRS 9 / CECL removes the large discrepancies of previous accounting standards but does not completely eliminate them)

2: Enable Scenario Analysis and Stress Testing of Credit Assets

Support analysis and stress testing under a complete range of probability-weighted scenarios

Embedding and Use in Business Operations

1: Clear Objectives

The CPM organization and resources aim to serve fulfilling defined Objectives. Objectives are defined in terms of measurable Performance Targets with
specific quantification formulas and applicable time periods

CPM Objectives should align with the institutional mission and strategy and Risk Appetite

Objectives should align with the stated CPM mandate to ensure realizability

Multiple Objectives should minimize conflicts but in any case should be managed jointly

5: Embedding Objectives In Employee Contracts

Internal / External Linkages

1: Consistency with Other Reporting

CPM Metrics and Reports must have a well established relationship with other reporting frameworks (where applicable), with an established waterfall report explaining the differences. This applies for examples: